Gone are the days when you go to work for the same company for 30 or 40 years and retire with a pension and gold watch. Since the advent and ever growing popularity of company-sponsored retirement plans, such as 401(k)s, employees have been forced to take a more active role in the preparation for their retirement.
This active role also includes that seemingly monumental task of keeping track of “old” retirement plans from former jobs. We live in a world where changing jobs is—for most—a fact of our adult life. So the question is: What do we do with that retirement plan when we either change jobs or retire? Before we dive into the nuts and bolts of how to roll a plan over, let’s briefly discuss the why.
Generally speaking, company-sponsored retirement plans offer their participants limited choices for investment options. This is the main reason for rolling over an old plan into an IRA. Whether you are retiring or changing jobs, it is often wisest to have your assets in the company plan “rolled” into a Rollover IRA at a custodian of your choosing. Once this is accomplished, you have the option of choosing whatever investments you desire (with some limitations, such as uncovered options) and are not limited to one particular mutual fund family, which is often the case in company sponsored plans.
That’s the why; now on to the how. Typically this process is handled by your former employer. You only need to inform your former employer of your desire to have your assets transferred into an IRA account you have set up at a custodian (Schwab, Fidelity, etc.). The company will most likely have paperwork to complete that will request information such as where the money should be sent, to whom the check should be made payable, etc. It is important to understand that the check should always be made payable to the custodian (or new employer in the benefit of your name if you choose to roll the assets into your new plan). This will ensure that you never take possession of the money, and subsequently the funds will not be subject to an early withdrawal penalty or tax. If you receive the money, it is considered a distribution and therefore subject to a mandatory 20% withholding for federal income taxes.
If for some reason the rollover becomes a taxable event, you could look into making an indirect rollover. An indirect rollover takes place when a taxpayer receives a distribution check from his former employer, less the mandatory 20% withholding. You would then deposit the indirect rollover into your IRA within the allowable 60-day rollover period. However, an indirect rollover can lead to difficulties and even some unwanted tax consequences. Consider the following:
John Doe has $500,000 in his retirement plan on the day he retires, March 15, 2008. John decides he needs a distribution from his retirement plan for a new boat. The company pays out his distribution in the form of a check to him for $400,000, after the 20% mandatory withholding, in this case $100,000. On April 30, 2008, John decides not to purchase the boat and that it would be better to roll over his retirement account into an IRA so it can grow tax-deferred until withdrawal. He is allowed to do this because it is within 60 days of the initial withdrawal. John takes the $400,000 received from his distribution and puts it into his IRA account.
Now John has two options to choose from regarding the additional $100,000 withheld. He can come up with the additional $100,000 out of his personal funds, which will be returned to him as a tax refund once he files his 2008 tax return, or John can decide not to contribute the additional $100,000 and pay ordinary income taxes on the $100,000 withheld because this is considered a partial distribution. The $100,000 may also be subject to an additional 10% withholding if John is under the age 59½.
Clearly there are several solutions when it comes to the treatment of company-sponsored retirement plans at the time of job change or retirement. In a situation where you do not need the money immediately, rolling over the funds and continuing tax-deferred growth until a withdrawal is needed or required is a smart play. Given the complexities and the abundance of options available, it is always advisable to seek the guidance of a professional. For more information regarding this topic, please contact Henssler Financial at 770-429-9166, or [email protected].